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January 8, 2013

Social Security’s Old Forecasting Method Hides New Time Bomb, Researchers Say

Study says government needs to hire statisticians, as archaic forecasting method understates the system’s shortfall by two years

Social Security checks being processed. (Photo: AP)

Washington’s restoration of the employee’s portion of the payroll tax that funds Social Security may be good news or bad news, depending on your perspective.

But what seems definitely to fall into the latter category is new research indicating that Social Security, even with the fresh funding boost, is on shakier ground than generally thought.

In a Sunday New York Timesop-ed, researchers Gary King of Harvard and Samir Soneji of Dartmouth argue that the Social Security Administration is using outdated methods to project longevity and therefore understates the system’s shortfall.

The two professors forecast that Social Security’s trust funds will be depleted two years earlier than the government’s current 2033 estimate, meaning there are just 18 years before a program that Americans across the board support and rely on faces a funding crisis.

The issue comes at a time when discussions of spending and taxation are near on the political calendar, but while partisan rancor and stalemate are unusually high as well. Nevertheless, King and Soneji warn “the longer we ignore the problem, the more disruptive any change will need to be to keep Social Security alive.”

The basis for their timeline compression, discussed at length in a longer article in the academic journal Demography, is a finding that the Social Security Administration projections underestimate Americans’ longevity and omit significant health trends, like reduced smoking and improved treatment of heart disease.

Specifically, King and Soneji say that Social Security relies heavily on actuaries using 1930s-era forecasting methods, but seem to have missed the revolution in big data and employ few statisticians capable of making accurate predictions. The result, they say, is that “more retirees will receive benefits for longer than predicted, supported by the payroll taxes of relatively fewer working adults than projected.”

The two researchers, with the cooperation of the Social Security Administration, examined how the agency made its forecasts and found its methods are prone to error and political interference.

“This may explain why the agency’s forecasts have, at times, changed significantly from year to year, even when there was little change in the underlying data,” they write.

The authors outline familiar, painful options to save a program they say has “lifted generations of elderly people out of poverty.” These include raising the retirement age, now gradually rising from 65 to 67, still higher to 69 or 70; increasing payroll taxes still higher; limiting annual cost-of-living adjustments; reducing benefits; or some combination of the above.

As the public debates these issues, the authors also recommend the Social Security Administration add statisticians on staff to institute up-to-date quantitative methodologies.

The Times article has generated further attention of economic bloggers, in some cases adding to the seeming direness of the problem.

For example, the Daily Beast’s Megan McArdle notes that downside surprises have been far more common than upside surprises in Social Security trust fund projections.

She notes that massive economic booms, people delaying retirement and mass unexpected mortality produce upside surprises while slow growth, people retiring early (often because of a slow economy) and people living longer produce downside surprises. She asks: "Which of these sets of things seems more likely over the next ten years?”

The American Enterprise Institute’s Andrew Biggs, writing on the conservative think tank’s blog on Tuesday, finds the researchers’ shortfall worries plausible. But he says they got the politics wrong when they stated that in the recent election both parties agreed that Social Security should not be reformed.

“Romney, in fact, proposed indexing the retirement age to longevity along with reducing the growth of benefits for middle and high earners,” he writes. “President Obama, however, to date has made no proposals to fix Social Security.”

Brookings Institute scholar Pietro Nivola cites a Pew Research survey he says shows Americans are not keen on raising the Social Security retirement age, a key path to shoring up the retirement trust’s finances.

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Check out more stories on Social Security: Time Bombs, Boomers, Widows and Secrets at AdvisorOne.